The Biggest Enemy to Your Retirement Future

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Five years ago, Ryan Rainbolt of Bakersfield, California, got news no one wants to hear: He was getting laid off. With no emergency fund to speak of, he quickly realized the bills wouldn’t stop when his paychecks did. That’s when the panic set in.

So Ryan tapped into the only stash of money he had: his 401(k).

“My first instinct was to pull the $6,000 that I had in my 401(k) to live off of. After taxes—eek!—I received my $4,500. Instead of being smart with the money, I felt empowered and went on a spree,” Ryan says. He gave his mom one-third of the money; paid off a few small debts; and used the rest to fund a vacation, weight-lifting equipment and lots of dinners out.

“I was broke by the time my unemployment check came four weeks later,” he adds.

Cashouts Account for Two Out of Three 401(k) Dollars Lost

Ryan’s story is just one of many throughout America. When 401(k) plans spring a leak, research shows it’s often because someone cashed out between jobs to solve a short-term money problem. And it’s having a huge effect on Americans’ ability to cover their retirement expenses.

According to a recent Employee Benefits Research Institute report, 401(k) cashouts at a job change make up two-thirds of the total money lost from early withdrawals. That’s twice the impact of loan defaults and hardship withdrawals combined.

“Knowing what I know now, I wish I would have never cashed it out,” Ryan says. “Even without contributions, the interest would be racking up.”

He’s right. If Ryan had rolled his 401(k) over into an IRA with good growth stock mutual funds, his nest egg could have been worth between $298,000 and $625,000 by the time he retired. And that’s if he never added another penny to the pile! Ouch.

There’s No Point in Wallowing in Regret

You can’t change the past, but you can focus your energy forward. That’s what Ryan has done. After just a few months working Dave’s Baby Steps, he knows his family could make it through another lay-off without stealing from their future.

“Because of the knowledge we've applied, we can fully cover our bills for one month, which would give us ample time to find a job, even if it was just at the local fast-food joint,” Ryan says. And he’s only just begun! It just goes to show that it’s never too late to do the right thing.

Want to build a better tomorrow? Here are three steps to get you started today.

1. Set a Firm Financial Foundation

If you’re saving for retirement but don’t have an emergency fund yet, you’re putting the roof on before laying the foundation. Put a temporary pause on your retirement contributions until you’ve got the first three Baby Steps out of the way.

–First, get $1,000 in a starter emergency fund so you don’t have to use debt to fix your car when it breaks down.
–Next, pay off all non-mortgage debts to free up your most powerful wealth-building tool: your income.
–Then, stockpile three to six months of expenses in your emergency fund so you can handle whatever life throws your way without dipping into your 401(k).

Once you’ve got these steps in place, go back to investing 15% of your household income into tax-advantaged retirement accounts like a 401(k) or Roth IRA.

2. Changing Jobs? Roll Over Instead of Cashing Out

When you leave a job, you have three options: Leave your 401(k) money where it is, roll it over into an IRA, or cash it out.

–Cashing it out is bad because you pay out the nose in taxes—a 10% penalty plus your tax rate—and lose out on the opportunity to grow your nest egg into big bucks.
–Leaving it alone hampers your growth potential because company 401(k) plans offer a limited selection of funds and continue charging administrative fees.
–Rolling your 401(k) over into an IRA is best because it keeps your nest egg intact and gives you access to more than 8,000 mutual funds.

To roll your 401(k) over, start by requesting a direct transfer from your 401(k) to a traditional IRA. Don’t let your old 401(k) provider write the check out to you, or you’ll be penalized for taking an early withdrawal.

If you can scrape up enough cash to cover the taxes, then convert your traditional IRA to a Roth IRA. That enables your entire retirement savings to grow tax-free instead of tax-deferred. What’s the difference? Let’s take Ryan’s numbers as an example. If he had rolled his 401(k) over instead of cashing out, he could have either paid taxes on $6,000 on the front end by converting to a Roth IRA or on a possible $600,000 at retirement by leaving it in a traditional IRA.

3. Get an Expert’s Advice

Changing jobs can bring a lot of uncertainties as you forge a new future. Your retirement outlook shouldn’t be one of them.